Many homes are bought and sold with the use of what is referred to as a conditional offer. A conditional offer is an offer which only becomes firm and binding if certain conditions can be satisfied. During the conditional period, often a short period of time, the deal is on hold. If the outstanding conditions become satisfied, the offer becomes firm and binding. If not, the deal ends. Two of the most common conditions in real estate transactions involve financing and home inspections. The purchaser will often submit an offer which is conditional on it arranging ‘satisfactory’ financing and on it obtaining a ‘satisfactory’ home inspection.

Many in the real estate industry have wondered exactly what is meant by the term ‘satisfactory’. The reason to understand what the term means is simple. If a buyer submits a conditional offer to a seller, and then subsequently changes its mind, can the buyer use these conditions to simply back out of the deal? Who determines what is a ‘satisfactory’ home inspection or what is ‘satisfactory financing’?

Clauses that contain the word ‘satisfactory’ have a subjective and objective meaning. Satisfactory means satisfactory to a reasonable person. In other words, there is an obligation on the purchaser to act reasonable in the circumstances. Such clauses are not purely subjective so as to allow a buyer to make a decision based purely on personal preference. Nor does the clause imply a rigid objective standard. The clause contains both a subjective and objective standard.

Looking at the home inspection clause first, a buyer cannot use the clause to arbitrarily back out of a deal. The objective standard would require the buyer to act reasonably by having the property looked at by a home inspector. Once the buyer has the inspection done, the subjective element comes into play. Thus, the buyer would have the opportunity to review the report. If there were significant problems requiring costly repairs, this might allow the buyer to terminate the transaction at this point. However, the buyer must still act reasonably when making this subjective assessment.

The same logic applies to the financing clause. The objective element would require the buyer to make reasonable efforts to obtain a satisfactory mortgage. This means that the buyer must apply for the mortgage. Doing nothing would likely not meet this objective element of the test. Once the objective element of the test has been met, the buyer can make a subjective assessment in deciding to waive the condition. So, if the buyer cannot obtain the necessary amount of financing or if the interest rate on the mortgage is too high, the buyer may be able to take advantage of the financing clause. However, the continuing obligation to act reasonably in the circumstances remains.

The typical “conditional on satisfactory financing/inspection” does not provide a buyer with the ability to cancel a deal for any reason. If buyers find themselves in an uncertain situation, they should consult with an experienced real estate lawyer.